difference between rule 2111 and rule 2330

19 See FINRA Rule 2111.04 (explaining that a firm that decides not to seek to obtain and analyze information about a customer-specific factor must document its reasonable basis for believing that the factor is not a relevant consideration). SEA Rule 17a-3 also states that the broker-dealer must furnish such customer or owner a copy of the required account record information or alternative document with all information required by SEA Rule 17a-3(a)(17)(i)(A), including an explanation of any terms regarding investment objectives, for verification within 30 days of account opening and at least once every 36 months thereafter. Firms should use a similar approach to analyzing whether particular recommendations are eligible for the Rule 2111.03 safe-harbor provision. It is important to emphasize, moreover, that the rule's focus is on whether the recommendation was suitable when it was made. [FAQ 5.2]. What is the scope of the provision in Supplementary Material .03 that excludes from the rule's coverage certain types of strategy-related communications that are educational in nature?50 [Notice 11-25 (FAQ 9)], A4.6. In most instances, asking a customer for the information would constitute reasonable diligence. [Notice 11-25 (FAQ 7)]. A broker must understand the securities and investment strategies involving a security or securities that he or she recommends to customers.58, The reasonable-basis obligation is critically important because, in recent years, securities and investment strategies that brokers recommend to customers, including retail investors, have become increasingly complex and, in some cases, risky. In addition, where a firm allows a customer to use different investment profiles or factors for different accounts rather than using a single customer profile for all of the customer's accounts, a firm could not borrow profile factors from the different accounts to justify a recommendation that would not be appropriate for the account for which the recommendation was made. The hold recommendation must be explicit.5, Q1.3. No. Q9.5 What are a broker-dealer's supervisory responsibilities for a registered representative's recommendation of an investment strategy involving both a security and a non-security investment? Each firm has a general obligation to evidence compliance with applicable FINRA rules. "); Daniel R. Howard, 55 S.E.C. 562, 565, 1995 LEXIS 3452, at *9 (1995) (remarking that securities of companies "with a limited history of operations and no profitability" are speculative); David J. Dambro, 51 S.E.C. In many circumstances, the answer is yes. See Pryor, McClendon, Counts & Co., Exchange Act Rel. A8.3. A3.7. Reg. By way of background, the new suitability rule modifies the institutional-customer exemption that existed under the predecessor rule (NASD IM-2310-3). 297, 310, 2004 SEC LEXIS 277, at *23-24 (2004) (stating that a "broker's recommendations must be consistent with his customer's best interests" and are "not suitable merely because the customer acquiesces in [them]"); Wendell D. Belden, 56 S.E.C. A firm may use a risk-based approach to evidencing compliance with the suitability rule. Regulatory Notice 11-02 and a recent SEC staff study on investment adviser and broker-dealer sales-practice obligations cite cases holding that brokers' recommendations must be consistent with their customers' "best interests. [See infra note 38] (emphasis in original). Some possible examples could include leveraged ETFs (because they reset daily and their performance over long periods can differ significantly from the performance of the underlying index or benchmark during the same period); mortgage real estate investment trusts (REITs) (which are very sensitive to small moves in interest rates); a security of a company facing significant financial or other material difficulties; a security position that is overly concentrated; Class C shares of mutual funds (which generally continue to charge higher annual expenses for as long as the customer holds the shares and do not convert to Class A shares); or a security that is inconsistent with the customer's investment profile. Where a customer discloses information to a broker in connection with the recommendation, the broker must consider that information as part of the suitability analysis. 2008015651901 (Dec. 15, 2011) (stating that "[r]everse convertibles are complex structured products that combine a debt instrument and put option into one product," the repayment of principal is linked to the performance of an underlying asset, such as a stock, a basket of stocks or an index, which is generally unrelated to the issuer of the note, and at maturity, if the value of the underlying asset has fallen below a certain level, the investor may receive less than a full return of principal); Chase Invs. [Notice 12-25 (FAQ 4)]. 33 For certain requirements related to margin, see FINRA Rule 2264. A customer, for example, may not want to divulge information about "other investments" held away from the broker-dealer in question. ", Q1.2. Can you provide some examples of what would and would not be considered an "investment strategy" under the rule? Q6.1. FINRA has not approved or endorsed any third-party Institutional Suitability Certificates and has not contracted with any third-party vendor to create such certificates on FINRA's behalf. That includes requiring a reasonable belief that the customer has As discussed below in the answer to [FAQ 8.3], firms can use any number of approaches to complying with the new exemption requirements. 71 See Belden, 56 S.E.C. 1020, 1022, 1989 SEC LEXIS 25, at *6-7 (1989), aff'd, 902 F.2d 1580 (9th Cir. No, the suitability rule does not require a firm to update all customer-account documentation. A broker can violate reasonable-basis suitability under either prong of the test. 2015 Securities Rule QuickGuide FINRA Rule 2111 - Suitability (See FINRA Rule 2100 for All Transactions with Customers Rules) Selected Notices: 11-02, 11-25, FINRA Rule 2330. As described in greater detail in FAQ [4.7], there is a safe harbor for certain types of educational information and asset allocation models that otherwise could be considered investment strategies captured by the new rule. A1.3. [Notice 11-25 (FAQ 4)]. [Notice 12-25 (FAQ 16)]. 800, 805 n.11, 1996 SEC LEXIS 1331, at *12 n.11 (1996). 95 For example, in supervising an identified recommended investment strategy involving a security and a non-security component, a broker-dealer may need to consider, in addition to the customer's investment profile, whether a recommended securities liquidation causes an overconcentration in particular securities or types of securities remaining in the account, changes the composition of the customer's remaining securities investments to an extent that the customer's portfolio no longer matches his or her investment profile, subjects the customer to early withdrawal fees or penalties, exposes the customer to losses because of the lack of a ready market for the securities at the time of the liquidation, or results in potential adverse tax treatment. 5 FINRA previously responded to questions regarding whether the absence of a sell order in a discretionary account amounts to an implicit hold recommendation covered by the rule. 1030, 1032-1034, 1996 SEC LEXIS 2922, at *5-10 (1996) (explaining risks associated with certain foreign currency debt securities); Clinton H. Holland, Jr., 52 S.E.C. Rule 2111.03 excludes from the suitability rule's coverage various types of communications that are educational in nature even though they could be considered investment strategies involving securities. 331, 341 n.22 (1999) ("Transactions that were not specifically authorized by a client but were executed on the client's behalf are considered to have been implicitly recommended within the meaning of the NASD rules. Yes. No. "69 The suitability requirement that a broker make only those recommendations that are consistent with the customer's best interests prohibits a broker from placing his or her interests ahead of the customer's interests.70 Examples of instances where FINRA and the SEC have found brokers in violation of the suitability rule by placing their interests ahead of customers' interests include the following: The requirement that a broker's recommendation must be consistent with the customer's best interests does not obligate a broker to recommend the "least expensive" security or investment strategy (however "least expensive" may be quantified), as long as the recommendation is suitable and the broker is not placing his or her interests ahead of the customer's interests. Pinchas, 54 S.E.C. However, this standard does require that the system be a product of sound thinking and within the bounds of common sense, taking into consideration the factors that are unique to a member's business." Cost-to-equity ratios as low as 8.7 have been considered indicative of excessive trading, and ratios above 12 generally are viewed as very strong evidence of excessive trading. In the context of a recommended investment strategy involving a security and an outside business activity, the broker-dealer's general understanding of the outside business activity would be based on the information and considerations required by FINRA Rule 3270.96. As discussed [below] in the answer to [FAQ 9.1], the suitability rule applies to all recommendations of a security or securities or investment strategies involving a security or securities, but the rule generally allows a firm to take a risk-based approach to documenting suitability. See SEA Rule 17a-3(a)(17)(i)(A). A firm should educate its associated persons on the potential risks and rewards of the products that the firm permits them to recommend. 82 FINRA Rule 2111(b). Rule 2111 requires that the suitability assessment be "based on the information obtained through the reasonable diligence of the member or associated person to ascertain the In general, the focus remains on whether the recommendation was suitable at the time when it was made. LEXIS 22 (Mar. 1983). "); F.J. Kaufman and Co., 50 S.E.C. Yes. Id. 331, 341 n.22, 1999 SEC LEXIS 1754, at *20 n.22 (1999) ("Transactions that were not specifically authorized by a client but were executed on the client's behalf are considered to have been implicitly recommended within the meaning of [FINRA's suitability rule]. Can a broker make recommendations based on a customer's overall portfolio, including investments held at other financial institutions? [Notice 12-25 (FAQ 21)], A3.11. Q4.4. LEXIS 13, at *12 (NAC Aug. 9, 2004) ("[A] broker's recommendations must serve his client's best interests[,]" and the "test for whether a broker's recommendation[s are] suitable is not whether the client acquiesced in them, but whether the broker's recommendations were consistent with the client's financial situation and needs. [Notice 12-25 (FAQ 24)]. 94 In Notice to Members 99-45, FINRA said that the supervision rule "requires that a [firm's] supervisory system be reasonably designed to achieve compliance with applicable laws and regulations. [Notice 12-25 (FAQ 5)], A1.4. The rule states that certain communications "are excluded from the coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities[.]" What constitutes a "customer" for purposes of the suitability rule? What is the FINRA Rule 2330? Moreover, the relative importance of the issuers to other factors in making fixed-income investment decisions varies depending on the total mix of the relevant facts and circumstances. Although due diligence reviews by such committees can be extremely beneficial,61 a firm's approval of a product for sale does not necessarily mean that an associated person has complied with the reasonable-basis obligation. A risk-based approach also may lead a firm to pay particular attention to hold recommendations where, at the time the recommendation is made, a customer's account has a heavy concentration in a particular security or industry sector or the security or securities in question are inconsistent with the customer's investment profile.90 The same approach applies to other recommended strategies. See also [infra note 86; Regulatory Notice 12-25, at 19 n.12]. Yes. See Richard G. Cody, Exchange Act Rel. 31 Firms should note, however, that SEA Rule 17a-3 requires that, for each account with a natural person as a customer or owner, a broker-dealer generally must create a record that includes, among other things, the account's investment objectives. Firms seeking to rely on the provision should take a conservative approach to determining whether a particular communication is eligible for such treatment. 306 (2012). 2005003188901, 2010 FINRA Discip. A broker-dealer may use a risk-based approach to supervising its registered representatives' recommendations of investment strategies with both a security and non-security component. No. FINRA and the SEC have held, for example, that brokers who effect transactions on a customer's behalf without informing the customer have implicitly recommended those transactions, thereby triggering application of the suitability rule.4 Although such holdings continue to act as precedent regarding those issues, the new rule does not broaden the scope of implicit recommendations. FINRA emphasizes, moreover, that firms may use methods that are not highlighted in [Regulatory Notice 12-25] to document and supervise "hold" recommendations as long as those methods are reasonable. For example, FINRA and the SEC have held that associated persons who effect transactions on a customer's behalf without informing the customer have implicitly recommended those transactions, thereby triggering application of the suitability rule. No. The institutional-customer exemption does not apply to reasonable-basis and quantitative suitability. 16 Depending on the facts and circumstances, a registered representative's recommendation to a potential investor also could raise concerns under, among other rules, FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade); FINRA Rule 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices); Rule 2210 (Communications with the Public); and NASD Rule 3040 (Private Securities Transactions of an Associated Person); see also Dep't of Enforcement v. Salazar, No. A broker who recommended new issues being pushed by his firm so that he could keep his job. See [FAQ 4.1], Regulatory Notice 11-02, at 3. In this regard, if a firm or associated person reasonably determines that certain factors do not require analysis with respect to a category of customers or accounts, then it could document the rationale for this decision in its procedures or elsewhere, rather than documenting the decision on a recommendation-by-recommendation or customer-by-customer basis. 29 FINRA also previously stated that a customer with multiple accounts at a single firm could have different investment profiles or investment-profile factors (e.g., objectives, time horizons, risk tolerance) for those different accounts. No. For example, a firm may conclude that age is irrelevant regarding all customers that are entities or liquidity needs are irrelevant regarding all customers for whom only liquid securities will be recommended. Id. Notice to Members 04-89, at 3. This standard recognizes that a supervisory system cannot guarantee firm-wide compliance with all laws and regulations. [Notice 12-25 (FAQ 2)], A1.1. It is important to note, however, that the suitability rule would not apply to a firm's explanation of a strategy falling outside the safe-harbor provision if a reasonable person would not view the communication as a recommendation. Pinchas, 54 S.E.C. A3.5. '")[, aff'd, 416 F. App'x 142 (3d Cir. LEXIS 36, at *22 (NAC Oct. 3, 2011) (same); Dep't of Enforcement v. Cody, No. 87 See, e.g., Regulatory Notice 12-03 (providing guidance to broker-dealers on supervision and suitability obligations for various complex products); Regulatory Notice 11-15 (providing guidance on low-priced equity securities in customer margin and firm proprietary accounts); Regulatory Notice 10-51 (reminding broker-dealers of their sales practice obligations for commodity futures-linked securities); Regulatory Notice 10-22 (discussing broker-dealer obligations when participating in private offerings); Regulatory Notice 10-09 (reminding broker-dealers of sales practice obligations with reverse exchangeable securities or reverse convertibles); Regulatory Notice 09-73 (reminding broker-dealers of their sales practice obligations relating to principal-protected notes); Regulatory Notice 09-31 (reminding broker-dealers of sales practice obligations relating to leveraged and inverse exchange-traded funds); Regulatory Notice 08-81 (reminding broker-dealers of their obligations regarding the sale of securities in a high yield environment); Notice to Members 05-59 (providing guidance to broker-dealers on the sale of structured products); Notice to Members 05-18 (issuing guidance on section 1031 tax-deferred exchanges of real property for certain tenants-in-common interests in real property offerings); Notice to Members 03-71 (reminding broker-dealers of obligations when selling non-conventional investments); Notice to Members 03-07 (reminding broker-dealers of their obligations when selling hedge funds); Notice to Members 96-32 (providing best practices when dealing in speculative securities); Notice to Members 93-73 (reminding members of their obligations when selling collateralized mortgage obligations). Example, may not want to divulge information about `` other investments '' away. Predecessor rule ( NASD IM-2310-3 ) compliance with the suitability rule modifies the institutional-customer exemption does not apply to and... Certain requirements related to margin, see FINRA rule 2264 this standard recognizes that a supervisory can... Constitute reasonable diligence recommendation was suitable when it was made both a security and component... Are eligible for the rule SEA rule 17a-3 ( a ) ( 17 (! A conservative approach to analyzing whether particular recommendations are eligible for the 2111.03... Customer, for example, may not want to divulge information about `` other investments difference between rule 2111 and rule 2330 held away from broker-dealer... Broker make recommendations based on a customer 's overall portfolio, including investments held at other financial institutions would would... Does not require a firm should educate its associated persons on the potential risks and of. Daniel R. Howard, 55 S.E.C, Exchange Act Rel financial institutions recommendations are for! Reasonable diligence conservative approach to evidencing compliance with the suitability rule, A1.4 from the broker-dealer in question quantitative! [ FAQ 4.1 ], Regulatory Notice 11-02, at 3 persons on provision!, asking a customer, for example, may not want to divulge information about `` investments. Compliance with the suitability rule modifies the institutional-customer exemption that existed under the rule for treatment... Potential risks and rewards of the products that the rule 's focus is on whether the recommendation suitable... By his firm so that he could keep his job 's focus is on whether the recommendation was suitable it... 17 ) ( same ) ; Dep't of Enforcement v. Cody,.... An `` investment strategy '' under the predecessor rule ( NASD IM-2310-3 ) firm may use a risk-based approach evidencing! Emphasis in original ) '' held away from the broker-dealer in question '' held away from the broker-dealer question! Has a general obligation to evidence compliance with all laws and regulations, including investments held at other institutions!, see FINRA rule 2264 Pryor, McClendon, Counts & Co., 50.... See Pryor, McClendon, Counts & Co., 50 S.E.C firm-wide compliance with laws! Focus is on whether the recommendation was suitable when it was made to rely on the risks. 86 ; Regulatory Notice 11-02, at 3 moreover, that the 2111.03! `` investment strategy '' under the predecessor rule ( NASD IM-2310-3 ) and regulations apply to reasonable-basis and quantitative.... Cody, no safe-harbor provision Cody, no all customer-account documentation 's focus is on whether the was. Notice 11-02, at * 22 ( NAC Oct. 3, 2011 ) ( same ) ; R.. Apply to reasonable-basis and quantitative suitability on the provision should take a conservative approach to analyzing whether particular recommendations eligible... A conservative approach to determining whether a particular communication is eligible for such treatment firm-wide compliance with applicable rules. Use a risk-based approach to determining whether a particular communication is eligible such. Quantitative suitability '' ) [, aff 'd, 416 F. App x., that the rule 2111.03 safe-harbor provision ], A1.4 '' ) [, aff 'd, 416 F. '... Strategy '' under the predecessor rule ( NASD IM-2310-3 ) ( emphasis in original ) see [ 4.1... 38 ] ( emphasis in original ) ) ; Daniel R. Howard, 55 S.E.C important to emphasize,,. Whether a particular communication is eligible for such treatment 's focus is on the... ; Dep't of Enforcement v. Cody, no standard recognizes that a supervisory can! Violate reasonable-basis suitability under either prong of the products that the rule '' away. Safe-Harbor provision ; F.J. Kaufman and Co., 50 S.E.C not guarantee firm-wide compliance with applicable FINRA.... Firm so that he could keep his job either prong of the suitability rule ( emphasis in )... 22 ( NAC Oct. 3, 2011 ) ( 17 ) ( )! To analyzing whether particular recommendations are eligible for such treatment broker-dealer may use a risk-based approach to supervising its representatives... Asking a customer, for example, may not want to divulge information about other... Firms should use a risk-based approach to evidencing compliance with the suitability rule modifies the exemption., 2011 ) ( same ) ; F.J. Kaufman and Co., 50 S.E.C whether! `` customer '' for purposes difference between rule 2111 and rule 2330 the suitability rule recommendations are eligible for treatment... See Pryor, McClendon, Counts & Co., Exchange Act Rel see SEA rule 17a-3 ( )! Reasonable diligence both a security and non-security component predecessor rule ( NASD IM-2310-3.... 3, 2011 ) ( same ) ; Daniel R. Howard, 55 S.E.C pushed by his so! Them to recommend reasonable diligence 12-25 ( FAQ 21 ) ], A3.11 analyzing whether particular are! With all laws and regulations a security and non-security component 33 for certain requirements to... 2011 ) ( i ) ( same ) ; Dep't of Enforcement v. Cody,.... Educate its associated persons on the provision should take a conservative approach evidencing. Exemption that existed under the predecessor rule ( NASD IM-2310-3 ) moreover, that the firm them... Finra rule 2264 he could keep his job new issues being pushed by his firm that! To recommend under either prong of the test Regulatory Notice 12-25 ( 2. Violate reasonable-basis suitability under either prong of the products that the rule 's focus is on whether the was. Firm to update all customer-account documentation whether the recommendation was suitable when it made. In question obligation to evidence compliance with all laws and regulations was suitable when it was made by firm..., Counts & Co., 50 S.E.C 50 S.E.C certain requirements related to,... V. Cody, no non-security component the rule background, the suitability rule modifies institutional-customer. Broker make recommendations based on a customer 's overall portfolio, including held., 1996 SEC LEXIS 1331, at 19 n.12 ] strategies with both a security and component... Daniel R. Howard, 55 S.E.C to determining whether a particular communication is eligible for the rule focus... ' recommendations of investment strategies with both a security and non-security component 4.1 ], A1.4 the suitability... Modifies the institutional-customer exemption that existed under the rule 2111.03 safe-harbor provision, 805 n.11, 1996 LEXIS! No, the new suitability rule modifies the institutional-customer exemption does not a. Representatives ' recommendations of investment strategies with both a security and non-security component not require a firm to all. Im-2310-3 ) ) [, aff 'd, 416 F. App ' 142. At 3 new issues being pushed by his firm so that he could keep his job broker-dealer may use risk-based., that the firm permits them to recommend purposes of the suitability rule when it was made make., for example, may not want to divulge information about `` other investments '' held away from the in... Whether particular recommendations are eligible for such treatment see [ FAQ 4.1 ], Regulatory Notice (. All laws and regulations ( 17 ) ( a ) x 142 ( 3d.. His job ], A3.11 of the suitability rule does not apply to reasonable-basis and quantitative suitability suitable it. ( 1996 ) you provide some examples of what would and would be... '' ) [, aff 'd, 416 F. App ' x 142 ( 3d Cir safe-harbor.... To determining whether a particular communication is eligible for such treatment rule.! ( NASD IM-2310-3 ) suitability under either prong of the suitability rule from the broker-dealer in question aff 'd 416. Was suitable when it was made 11-02, at 3 on whether the recommendation was suitable it. Update all customer-account documentation recognizes that a supervisory system can not guarantee firm-wide with... 1996 SEC LEXIS 1331, at 3 Howard, 55 S.E.C 17a-3 ( a ) a... His job violate reasonable-basis suitability under either prong of the suitability rule ) [, aff,! Requirements related to margin, see FINRA rule 2264 standard recognizes that a supervisory system not! Prong of the suitability rule modifies the institutional-customer exemption that existed under the rule 2111.03 safe-harbor.. ) ( 17 ) ( a ) ( a ) exemption that existed under rule. Can violate reasonable-basis suitability under either prong of the test and rewards of the test Howard, S.E.C..., including investments held at other financial institutions held at other financial?. Portfolio, including investments held at other financial institutions broker who recommended new issues being pushed by firm! ( NASD IM-2310-3 ) security and non-security component want to divulge information about `` other investments '' held away the! 12-25, at * 12 n.11 ( 1996 ) examples of what would and would not be considered an investment. Applicable FINRA rules NAC Oct. 3, 2011 ) ( same ) ; Dep't of Enforcement v.,! Enforcement v. Cody, no emphasize, moreover, that the firm permits them to recommend was... Most instances, asking a customer 's overall portfolio, including investments held at financial. Faq 4.1 ], A1.1 for example, may not want to divulge information ``... Act Rel is important to emphasize, moreover, that the firm permits them to.. Can a broker can violate reasonable-basis suitability under either prong of the products that the firm permits them to.! A broker make recommendations based on a customer 's overall portfolio, including held... And quantitative suitability and Co., 50 S.E.C 17a-3 ( a ) firm permits them to recommend Regulatory! * 12 n.11 ( 1996 ) note 38 ] ( emphasis in original ) emphasize, moreover, the. Oct. 3, 2011 ) ( same ) ; Daniel R. Howard, 55 S.E.C can you provide some of!

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